Firms decentralize through profit centers because (1) the divisional managers’ nearness to the market place provides relevant information regarding changes in the prices of inputs and outputs, and (2) more effective coordination of production factors should be obtained at the divisional level. One of the requirements of decentralization is a system of transfer pricing, a problem which is of concern to accountants and applied economists. The apparent benefits of divisionalization may have induced many companies to adopt a system of transfer prices even when there was no outside competitive market for transferring the intermediate product from one profit center to the other. Establishing a proper sys-tem of transfer price for such profit centers must satisfy these requirements: (1) the transfer prices must allow central management to evaluate as accurately as possible the performance of the profit centers in terms of their separate contributions to corporate profits; (2) the system of transfer pricing must motivate profit center managers to pursue their own self-interest in a manner which is conducive to the success of the company as a whole ; (3) the system must serve as a stimulus to managers to increase their efficiency without losing the autonomy of divisions as profit centers.

“In this paper, I focus on how altering the aggregation level can induce predictable preference patterns between actions. In particular, I concentrate on sequential aggregation, which is defined as a strictly coarser partitioning of a set of events, or measures relating to them, when such events are contingent upon one another and occur sequentially.”"Relevant Accounting," The Journal of Business (co-authored with George H. Sorter), April 1972.

“This paper presents a system of external accounting reports which differs significantly from both presently existing financial statements and alternatives thus far suggested in the literature. In the first section of the paper we discuss the measurement inputs required for efficient allocation of resources. We then suggest that accounting, as presently constituted, does not adequately fulfill these informational requirements, and we propose an alternative system to meet these needs. In the third section we illustrate the system by presenting its output the periodic account-ing reports-and analyze these reports in terms of the insights provided for users' needs. In the last section we conclude with implications for future research and for the development of the proposed system.”

"Effects of Some Probability Displays on Choices," Organizational Behavior and Human Performance, November 1972.

This research deals with deviations from the EV model. Ss in two experiments were required to select one of two mutually exclusive actions characterized by an identical probability of success. Each action, however, consisted of two sequential steps. The probability of success at the first step of one action was greater than the probability of success at the first step of the alternative action. Ss were made aware of the individual probabilities of success for each step as well as the joint probability of success. The EV model would predict that individuals would be indifferent in their selection of alternative actions. However, Ss were not indifferent; they systematically preferred actions in which the probability of success in the first step was higher. This preference for initial probability of success generally persisted with some exception throughout variations in experimental conditions designed to test for the stability of the effect.

"Involvement in Tasks and Choice Behavior," Organizational Behavior and Human Performance, February 1974.

This study explores deviations from the EV model when making preferences between luck tasks in which the subject is only partially involved with varying objective probabilities of success. Thirty-nine subjects in a laboratory experiment were required to select one of two mutually exclusive tasks characterized by an identical probability of success. Each task consisted of two events: in one of these events the subject himself was involved, and in the other, another individual was simultaneously involved. Subjects were presented with the individual probabilities of success associated with each of the events as well as with the joint probability of success. The probability of success associated with the event in which the subject was involved differed between the two tasks. An EV model would predict that the subjects would be indifferent in their selection between the two tasks. However, the subjects systematically preferred tasks in which higher probability of success attached to the event in which they were involved. This preference generally persisted throughout variations in experimental conditions designed to test for the stability of the effect. Some explanations for the observed phenomenon are offered."Effects of Information about Opportunity Costs on Decisions - An Experimental Approach," Journal of Accounting Research, (co-authored with Selwyn W. Becker and George H. Sorter), Autumn 1974.

An important question for accountants is whether information about OC should be provided by the accounting process. To answer this question at least partially, it is beneficial to determine whether OC are used in actual decision making. It is difficult to investigate this issue in a real situation since decision makers may be using OC obtained from non- accounting sources about which we have little or no knowledge. As a first step, we chose instead to investigate whether individuals in an experimental situation would rely on OC if information about them was provided.

The accounting literature has extensively discussed and tested income smoothing [2, 5, 7, 8, 9, 10, 11, 14, 15, 171. However, the role of extra- ordinary items in the "management" of income was not specifically and separately' tested for. The latter is the focus of this paper. For the purpose of our study we operationally define smoothing as the observed dampening of fluctuations about some level of income assumed to be normal for the firm. The object of smoothing is assumed to be the stream of ordinary in- come (before extraordinary items) per share.' From observing the stream of net income, and that of ordinary income before extraordinary items, we infer whether firms' managements behave as if they use extraordinary items either alone or incrementally in order to dampen the fluctuations of ordinary income.

"The Effect of Insider Trading Rules on Information Generation and Disclosure by Corporations," The Accounting Review, April 1977.

The paper examines the possible effects of insider trading rules on the incentives for firms to produce and disseminate information about themselves. The incentives to produce and disseminate information are examined analytically, both within a market free of insider trading rules and within a market with the existing insider trading rules. Thus, the incremental effect of insider trading rules on the incentives is assessed. It is concluded that the net effect of insider trading rules will most likely inhibit the generation, processing, and communication of inside information. And to the extent that insider information has allocative effects, the net effect of insider trading rules will be the deterrents of the production and dissemination of information that improves the allocation of resources. To the extent that insider trading rules are designed to prevent undesirable redistributions of wealth that could result from monopolistic access to information, and if this goal is to be taken for granted, then a more extensive regulation of what information is to be produced and disclosed may be needed to insure that information useful for allocation decisions is produced by the firm.

"The Smoothing of Income Numbers: Some Empirical Evidence on Systematic Differences Among Manager-Controlled and Owner-Controlled Firms," Accounting, Organizations and Society, Vol. 3, No. 2 (co-authored with Y. Kamin), 1978.

An examination of the effects of the separation of ownership and control on income smoothing is conducted under the hypothesis that management-controlled firms are more likely to be engaged in smoothing as a manifestation of managerial discretion and budgetary slack. Both “Accounting” and “Real” smoothing are tested by observing the behavior of discretionary expenses vis-à-vis the behavior of income numbers. The results confirm that a majority of firms behave as if they were income smoothers. A particularly strong majority is included among management-controlled firms with high barrier to entry.

"Some Hypotheses on the Pattern of Management's Informal Disclosures," Journal of Accounting Research (co-authored with V. Pastena), Autumn 1979.

There is a growing interest in the extent to which corporate management actions serve as a means of signaling managements' expectations to market transactors. Little attention, however, has been given to management's ability to effect overall production and dissemination of information that signals strategy. In this paper, we examine the pattern of information disclosure by management, both in the formalized assemblage of announcements concerning accounting measures and informally through press releases, announcements, etc.

In this paper we attempt to offer a framework to explain voluntary disclosures of segment information. Specifically, we identify a set of incentives which might have induced some companies to disclose segment information voluntarily and others to withhold it. These incentives develop through a comparison of the revision of expectations which would take place upon the disclosure of segment information, with revisions caused by consolidated-based information alone.

This paper proposes that managers, having the value of their human capital dependent on the performance of the firm they manage, and being unable to diversify away this risk, are expected to attempt to reduce their employment risk internally by project selection or by income smoothing, intended to stabilize the firm's income stream. An empirical investigation shows that manager-controlled firms exercise ‘income smoothing’ to a greater extent than owner-controlled firms, have relatively lower unsystematic risk and perhaps lower systematic risk.

This paper applies the Kalman filtering procedure to estimate persistent and transitory noise components of accounting earnings. Designating the transitory noise component separately (under a label such as extraordinary items) in financial reports should help users predict future earnings. If a firm has no foreknowledge of future earnings, managers can apply a filter to a firm’s accounting earnings more efficiently than an interested user. If management has foreknowledge of earnings, application of a filtering algorithm can result in smoothed variables that convey information otherwise not available to users. Application of a filtering algorithm to a sample of firms revealed that a substantial number of firms exhibited a significant transitory noise component of earnings. Also, for those firms whose earnings exhibited a significant departure from the random walk process, the paper shows that filtering can be fruitfully applied to improve predictive ability.

"The Sale of Controlling Interest by a Dominant Shareholder to a Third Party: A Financial Economic Analysis of the Governing Law in the United States and Canada," Case Western Reserve Law Review, 1986-87, Vol. 37, No. 1, lead article, pp. 1-40.

The present article is based on, but different from, another article by the author, “Individual Entrepreneurship and Corporate Entrepreneurship: A Tentative Synthesis,” which is included in Innovation in New Markets: The Impact of Deregulation in Airlines, Financial Markets and Telecommunications, Vol. 2, Gary Libecap (ed.), JAI Press, 1988.

Decisions of firms such as whether to purchase new equipment frequently rather than better maintain and purchase less frequently are influenced by the (accounting) depreciation policies they use if they are rate-regulated. It is shown that basing decisions on depreciation policies, while uneconomic without regulation, might become rational under regulation. Regulators can mandate depreciation policies for these firms. This paper identifies a class of depreciation rules which will eliminate management incentives to make uneconomic capital replacement and maintenance decisions under regulation.

This paper revisits the transfer pricing scheme proposed by J. Ronen in 1974 (Journal of Public Economics 3, 71–82) and the controversy it gave rise to (T. Groves and M. Loeb, Journal of Public Economics 5, 353–359). The latter suggested that through centralized decisions on commodity transfers, problems they point out in Ronen's decentralized scheme could be alleviated. I establish here that under the Ronen scheme, decentralized divisions within a firm or firms which exchange externalities within an economy will indeed communicate truthful information unless the divisions or the firms were to coordinate their messages. If coordination were to be ruled out, truth-telling would almost always prevail. Further, with a slight feasible modification of the scheme, efficient production and truth-telling become a unique equilibrium. This is accomplished without having to centralize decisions within the center.

"Dealing with Anomalies, Confusion and Contradiction in Fraud on the Market Securities Class Actions," (co-authored with Andrew R. Simmonds, and Kenneth Sagat), Kentucky Law Journal, Volume 81, Number 1, 1992-1993.

This Article examines and suggests remedies for the confusion and contradictions that have resulted and will result from the adoption of the semi-strong efficient market hypothesis as a legal truth in class action securities litigation."Incentives for Voluntary Disclosure": Journal of Financial Markets, 4 (4) 2001 309-357 (with Varda Yaari).

Rule l0b-5 of the 1934 Securities and Exchange Act allows investors to sue firms for misrepresentation or omission. Since firms are principal-agent contracts between owners - contract designers - and privately informed managers, owners are the ultimate firms' voluntary disclosure strategists. We analyze voluntary disclosure equilibrium in a game with two types of owners: expected liquidating dividends motivated (VMO) and expected price motivated (PMO). We find that Rule l0b-5: (i) does not deter misrepresentation and may suppress voluntary disclosure or, (ii) induces some firms to adopt a partial disclosure policy of disclosing only bad news or only good news.

Studies that explore the empirical association between accounting numbers and price-based measures cannot, by themselves, lead to inferences regarding the usefulness of alternative accounting policies. The Boone and Raman (2001) paper is one among many studies that employ a “value-relevance” methodology (finding associations between prices or measures derived wherefrom and accounting numbers based on alternative treatments) in an attempt to derive implications for accounting policy formulation. This paper dwells on the reasons why no such implications can be drawn from association studies, and why, under the best of circumstances, such studies can illuminate only one corner of the black box: does the market behave as if it both (1) believes and (2) attaches some weight to information provided to it?

This paper demonstrates that a post-announcement earnings drift, which is often advanced as an example of market irrationality, can arise even if traders act rationally on their information. Specifically, we show that in the presence of share supply variations which are unrelated to information, there is a positive correlation between the unexpected component of current public signals and future price changes. Such a correlation arises from the fact that while prices reveal private information that cannot be found in public signals, non-information based trading distorts the information content of prices relative to the implications of both private and public information. Under these circumstances, markets may appear semi-strong inefficient and slow to respond to earnings announcements even though information is processed in a timely and efficient manner. Our findings correspond well with previously documented empirical evidence and suggest that the robustness of earnings-based “anomalies” may be rational outcomes of varying uncertain share supply.

Valuation requires the prediction of future growth rate of persistent earnings, which depend on past and present internal, unobservable, investment decisions. In this study, we investigate the "management" of the series of growth rates in a multi-period principal-agent model with a moral hazard problem between owners (the principal) and the manager (the agent). We find that the manager's choice of efforts might yield a series of increasing expected growth rates, contrary to owners' preferences. Consequently, the extrapolation of expected future earnings of an owner-controlled firm should differ from that of a management-controlled firm."Policy Reforms in the Aftermath of Accounting Scandals": Journal of Accounting and Public Policy, 21 (2002) 281-286.

Enron’s collapse stunned the nation. A shocking series of revelations of accounting irregularities by major corporations followed. What happened?

We study analytically the effect of preliminary voluntary disclosure and preemptive preannouncement on the slope of the regression of returns on earnings surprise—the earnings response coefficient (ERC). When firms do not manage earnings, additional disclosure has no effect, and the ERC is proportional to price/permanent earnings ratio. If they manage earnings by attempting to inflate them, the response to (100% credible) negative earnings surprise is stronger than the response to (less than 100% credible) positive surprise. To avert litigation, firms that manage earnings adopt a partial voluntary disclosure strategy—either public revelation of good news and withholding bad news, or public revelation of bad news and withholding good news. Voluntary disclosure affects ERC on positive earnings surprise only, depending on what the firm reveals: the good- news revealing ERC (GRC) is higher than the bad-news revealing ERC (BRC), because good news enhances the credibility of the positive earnings surprise, even though the market discounts good news. Furthermore, preemptive pre-announcements improve ERC accuracy by narrowing the scope of earnings management."Post-Enron Reform: Financial Statement Insurance, and GAAP Re-visited": Stanford Journal of Law, Business & Finance", autumn 2002 Volume 8 Number 1.

This discussion aims to convince the reader convince the reader, first, that at least in the short term, incentives are required to elicit ethical conduct, and, second, that market incentives are necessary beyond legislative and/or regulatory reform.

The largest corporate bankruptcy filed in the U.S. that of Enron Corp in 2001 was preceded by a string of disclosures about the restatements of their financial statements. The presence of such errors that required restatements of the financial statements brings into focus the salience of two inter-related needs. The first is the need to assess the quality of the information contained in the financial statements as a basis for making projections about the future. The second is the need to actually make projections about future cash flows and aggregate these into a value for the security. Even if one assumes that accurate models are available for projecting cash flows, uncertainty about the quality of the financial statements can lead to pricing distortions and inefficient market allocations

In the aftermath of one of the worst financial and accounting scandals, The SEC and other regulatory bodies have initiated a flurry of reforms designed to improve corporate governance and to hopefully deter future abuses. The Sarbanes Oxley Act of 2002 (SOA) has imposed harsher penalties on errant directors and officers and significantly enhanced the role and responsibility of audit committees and independent directors. But the suggested reforms so far have failed to address the major problem that still besets corporate America today. Namely, the agency costs of managing corporations: CEOs, CFOs and other directors and officers serve their entrenched – insular interest to the detriment of shareholders. In this article, we intend to survey the landscape of the recent suggested reforms, especially as they relate to accounting and audit failures and evaluate their effectiveness in terms of their ability to alleviate the agency cost of conducting business. We will also offer a proposed reform which we believe can be an effective deterrent to financial and auditing failures.

The Sarbanes–Oxley Act has sought to reform the existing corporate governance mechanisms in order to alter the circumstances that led to the accounting debacles at Enron, WorldCom and so on. But other than adding and injecting additional regulatory layers, the Act stops short of providing a workable operating definition of corporate governance and does not effectively deal with the perverse incentives that have generated the 'urge' to 'cook the books'. This paper claims that at the very core of proper corporate governance is the communication of information that managers of corporations possess to outside investors. It is important that this communication be both relevant and truthful. This paper describes a mechanism that is designed to remedy corporate governance failures by realigning incentives of outside auditors with those of the shareholders. This is accomplished by insuring financial statements against losses incurred by shareholders that are caused by omissions or misrepresentations."Financial Accounting Theory and Research": Blackwell Encyclopedia of Management, Second Edition, Volume 1, Edited by Colin Clubb, 2005.

Financial accounting emerged in response to managers’ need to communicate to owners whether the latter’s capital has been preserved intact and whether investments have yielded income, and, if so, how much. Accounting is a tool by which management fulfils its stewardship function toward stockholders: management accounts for how it safeguards and manages the owners' resources. Seen from this perspective, accounting is a monitoring mechanism either demanded by stockholders or volunteered by management to minimize the diversion of resources to activities that do not serve the owners’ purpose. Over time, however, accounting has evolved to play an additional role that transcends this stewardship function: providing information for consumption and investment decisions. Thus, stockholders require reporting not only to obtain an agreed-upon measure of performance, but also to obtain information on the basis of which they can make future decisions. The latter can also be referred to as “signalling.”